5 benefits in thinking about revenue models right from the start


Add to FacebookAdd to DiggAdd to Del.icio.usAdd to StumbleuponAdd to RedditAdd to BlinklistAdd to TwitterAdd to TechnoratiAdd to FurlAdd to Newsvine

moneymanThere are a number of Web sites and applications — two of the most well known examples being Twitter and Facebook — that offer very good, free services. And over time, as they grow larger, the quest begins to find a revenue model or models to turn the service into something that actually resembles a sustainable business.

The problem is that after the fact, trying to find and attach a revenue model onto something that people know and expect to be free is difficult. There may or may not be technical difficulties in doing this, but there will almost certainly be business and cultural difficulties in adding revenue models after the fact.

A lot of people like to cite Google as the model for a company that started out without any revenue models and then figured out an incredibly successful one later on. There’s nothing wrong with wanting to be the next Google, but the story of Google’s revenue model success is not one that can be recreated simply by positive thinking and hard work. Ask the folks at Cuil about that one.

The conditions and circumstances, market opportunities and market needs may be totally different. There’s so much we don’t know about the market that leaving revenue generation to an afterthought is hardly good business strategy.

It’s great to tout 1,000,000 or 5,000,000 or even 100,000,000 “users” or “visitors”, but when they cost you money everyday instead of helping generate positive cash flow, more is not better. And this, after the fact thought process of figuring out revenue models, is problematic to say the least.

Instead, why don’t these companies consider revenue models right from the outset or very early into their startup process? Whether the revenue comes from users themselves, advertising, premium services, data collection and licensing or some other means, it’s very important to think this through upfront and act accordingly to understand and implement those models that make the most sense.

There are a number of benefits in thinking and working this way:

  1. It requires you to actually segment your buyers and your users
  2. It helps you understand who you are truly competing against
  3. It reinforces the value proposition to your existing and potential users or buyers
  4. It sets up a revenue-centric culture within your company
  5. It’s the right thing to do

Let’s look at each one of these in more detail.

1. It requires you to segment your buyers and users

Who is the target customer? Now that’s a common question that gets asked all the time for virtually every product or service. Unfortunately, too many times the answer comes back as “everyone”, or “consumers”, or “anyone who needs our product”, or something equally vague and not very helpful.

It’s not always easy to know everyone who will find value in an offering, but it really helps to start with at least one or two target groups. Understanding who they are, what they need, and the value your offering delivers are key to defining a sustainable revenue model.

A lot of times people don’t do this for fear of missing or eliminating key groups of people, but if you can’t identify the kinds of people who might pay for your product or service, how can you decide how much value it is to them and how much to charge?

Keep in mind that users and buyers are not always one in the same. Taking Google’s search engine as an example, the users are the people conducting searches through the site. That service is free to them. The buyers are those organizations that buy pay-per-click (typically Adwords) advertising that is displayed in the search results.

The system of connecting searchers with ad buyers (i.e. targeted ad placement when people are searching for information), creates an incredibly efficient and scalable engine for revenue, and it must be noted, one that few companies have been able to emulate with as much success.

2. It helps you understand who you are truly competing against

There is competition for virtually every product or service. For some it’s very obvious, and direct competitors can be listed without thinking. For others it’s not so obvious, but incredibly important to identify. Why? Because the word “competitor” must be thought of as “other options for your target buyer to achieve the same or similar result”.

If you are going to charge for something, you need to know how your target buyer spends their money today (if they do at all) for similar results. Too often focus is simply put on very similar offerings in the market, and using those offerings as a basis for thinking about revenue models.

But if you truly put yourself in the context of your buyer, understand their options, and what final results or outcomes they want, your perspective can change significantly.

Southwest Airlines sees their competitors not only as other airlines, but also cars and intercity buses. Why? Because these are the most likely alternatives that their target customers (budget minded travelers) would look to in order to travel between cities. Keep in mind that a lot of SouthWest flights are short-haul routes.

Similarly, when Intuit introduced Quicken, they viewed their competition as not only other home accounting software packages (of which there were many), but also the pencil and paper, because that was also a common option for people who wanted to perform home finance calculations.  The outcome — balancing a checkbook or simple budgeting — can be achieved by computer as well as by hand.

In both cases, clearly understanding their target users’ desired outcomes and their likely options helped the companies understand the value they could deliver and in Intuit’s case, a benchmark for the price they could charge.

3. It sets up a revenue-centric culture within your company

What do you call a business that doesn’t care about revenue? Answer: A hobby.

Employees in a business need to think and act for the benefit of the business. People are hired, culture is developed, processes are defined, decisions are made and systems are built that align with the objectives of the business. If the goals of the business (at least initially) do not involve revenue (in some form), the culture, decisions, processes, systems and people within the company will adapt to that.

And when at some point revenue becomes a priority, then changes, possibly significant ones, will have to be made to accommodate for that. Decisions, which were likely technology or user driven will need to start incorporating revenue and business considerations. Does your service or product have a licensing mechanism? Is it flexible enough to accommodate the business? What changes in the Engineering, Marketing or Finance teams are needed? Do you need to create a Sales team?

It sounds trivial, but it isn’t. Consider what happens when something as simple as a pricing change is required in an existing business. There are many existing internal AND external parties and processes that need to adapt to that change.

Now imagine the impact if that pricing change goes from “no pricing at all” to some form of pricing. New people would have to be hired, for example, in finance. New systems would have to be created to collect revenue and process it. New processes are needed to handle refunds, discounts, create financial reports etc. Decision making criteria need to change to focus on what can generate and sustain revenue. These are just some of the changes that would need to occur to create a culture in the company that is revenue centric.

Why not set up the company early on to manage and deal with these kinds of issues and possibly accelerate the process of generating revenue.

4. It reinforces the value proposition to your potential users or buyers

There is absolutely nothing wrong with providing a free service. If  the objective is to only have a free service and it can be funded then go ahead.

But most services are not created to be completely free forever. Even open source software, which originally was viewed as “free” has developed business and revenue models that leverage the value their customers derive from it. Redhat, Suse, MySQL and JBoss are all examples of very successful businesses founded on this so called “free” software model.

For any aspiring profitable business, there is a very clear need to identify upfront what is truly free (e.g downloading and using open source software) and what requires payment (e.g technical support for open source software). Not only does this delineate the difference between free and paid offerings but it also defines the relationship and expectations a customer or buyer will have with the company.

Flickr provides a good example of this in action. You can upload a fixed number of photos for free and share them with anyone, but for a large collection of pictures, there is a small  fee ($25 per year for a Pro account). Flickr commits to never deleting your photos, even if you fail to keep your paid account current. They’ll simply restrict your access to them.

So why is this important for customers/buyers? It positions the company very clearly as one that is in business to generate revenue, that will deliver a set of services or offerings that have some intrinsic value that costs actual money, and one that, if successful, will be around in a few years time to continue delivering the service that is being paid for.

I like free stuff as much as the next guy, but if I’m going to commit my time and effort to using someone’s services, I’d like to know that they’ll be around so I can continue to use them. Now, there are plenty of companies that charge for their services that go belly up, but that is not new to the Internet. That’s a simple fact of life for any business. But I’m sure you’d agree that it’s more likely that a company that DOES charge money for their service or has a very clear and scalable revenue model will be likely be around longer than one that doesn’t.

5. It’s the right thing to do

rightthingWhy are most businesses started? To make money? Well more bluntly, to make money for the founders and investors in the company. If that is the case, then it’s Business Basics 101 that understanding the market, potential customers, their buying needs, budgets, willingness to pay etc. are all critical to any form of business planning. So, why not start right and do some homework upfront?

It used to be the case that the investment to build a product was significant, typically involving manufacturing processes, sourcing from suppliers, warehouse and delivery expenses and logistics etc. But the combination of mature software development tools and the Web as the distribution medium has created an environment where creating and distributing the “product” is simple and rather inexpensive. In fact, identifying buyers, buyer needs, budgets etc. is likely harder than creating the product. So what do many people do? They build something and see “what sticks”.

While there is benefit to this approach, it should not be done without forethought to the business aspects that will underlie the offering. Both product definition and business planning need to be done together and up front. Just as iterations are needed to get the product right, iterations will likely be needed to get the business working well. Both product and business strategy need to evolve together, and as knowledge is gained and changes needed, then those changes can be made in tandem.

And while people will hold up the few successful companies, like Google, as their models for achieving success, it’s telling that they willfully ignore the myriad of companies that tried the same “we’ll figure out the revenue model later” approach and utterly failed.

Saeed

Advertisements

9 responses to “5 benefits in thinking about revenue models right from the start

  1. Very wise words indeed. Particularly #1.

    I am amazed at how many marketeers can’t even do a little segmentation and definition of target markets/customers.

    I hear “we want to sell to everybody, so we don’t segment” one more time I swear I will scream.

    Geoff

  2. I would also add that it sets the right expectation with your customer. Once a customer gets used to using a product for free or without ads, expect push back when you change your offering (see Facebook).

    Thanks,

    Josh

  3. I agree a great deal with what you way here. However, I would also venture to say that a lot of what makes these companies (Facebook, Twitter) remarkable is the fact that they grow quickly and take a huge market share. They depend heavily on the network effect in order for their product to be useful to their users. If only 10 of your friends use the service, you aren’t gonna stay for long. And if you don’t stay for long, the company can’t monetize your traffic.

    • Tim

      I agree with your point, to a point. 🙂

      While I agree that having lots of people use these services is a good thing, FaceBook, in particular, has not been able to come up with scalable ways of generating revenue.

      They are still burning huge amounts of cash. Why? They’ve got 200,000,000+ users, may of which are VERY active.

      Are there not aspects of their service they could monetize or value added services that could be sold?

      Friendster, YouTube and many other sites have failed in this regard.

      One site that started out with a clear value prop and a good revenue model is LinkedIn. They understood the value they were delivering and to whom and charged early on for it and generate healthy revenues. Yes, they have a free service, but many people also pay for the extended services.

      That’s the kind of thinking I’m talking about.

  4. Pingback: Twitter Trackbacks for 5 benefits in thinking about revenue models right from the start « On Product Management [onproductmanagement.net] on Topsy.com

  5. Anybody know whether CraigsList did the business model up front, vs. later?

    • Linda,

      Craigslist started as a simple email list. It evolved from there.

      But as I said in the last line of the article, one shouldn’t hold up the few successful companies as models to emulate, while ignoring the many many failed companies that didn’t start out thinking about revenue.

  6. Pingback: Tr.im should have figured out their revenue model first! « On Product Management

  7. Saeed, a perspective on segmenting:

    This is important because a lot of sales effort (with senior people pitching along with the product manager and architect as well) to a host of people. The cycles are long in B2B an longer with products targeted at governments and institutions.

    Unless the market is segmented well with a firm view on revenue streams, not only will people waste energy in making unnecessary sales calls, they shall also spend time making sense of feedback that should not have come in the first place. All this would put pressure on the development effort and timelines.

    A good post !